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The Department for Energy & Climate Change (DECC) has released the proposed CfD strike prices for renewables as part of its Electricity Market Reform (EMR) project, and provided further detail on the proposed Capacity Market which will further support the development of gas- fired generation in the UK.

The package of documents released on 27 June 2013 contains something for everyone within the UK energy industry.

In this briefing that accompanies our bulletin of 4 July 2013, we look at four aspects of the package in further detail.

Government has reiterated its commitment to support the low-carbon generation sector through the use of Contracts for Differences (CfDs) as part of the wider Electricity Market Reform (EMR) package through the publication of a further EMR Update on 27 June 2013.

Draft Strike Prices for Renewables Technologies published

A key component of last Thursday's announcement was publication by Government (working in conjunction with National Grid) of the initial draft Strike Prices for renewables technologies. The Strike Price in a CfD:

sets the level of the pre-agreed 'top-up' to the revenue which that generator will receive from selling its output into the market as usual (based on a market reference price); but

also puts a 'cap' on the total revenue available to that generator from the sale of its electricity, as generators must pay back the difference when the market reference price goes above the Strike Price (reducing, in theory, the cost to consumers).

Government considers that the draft Strike Prices are consistent with the level of support currently offered to renewables developers through the Renewable Obligation (the RO). The Strike Prices have been adjusted to take account of a number of elements (for example, increased price certainty, indexation to CPI rather than RPI, and that support will be available, in general, for 15 rather than 20 years), which Government believes will provide greater benefit to consumers.

There are now only 14 bands for renewables technologies (compared with 35 under the RO), which represents a deliberate step by Government to standardise support for each technology. Whether this is sustainable remains to be seen, given these broad bands can encompass various different technical approaches.

The headline £/MWh figures (2012 prices) announced by Government are set out in Appendix A to "Electricity Market Reform: Delivering UK investment" (the EMR Update):

The draft EMR Delivery Plan, expected to be published for consultation in July 2013 (possibly around the 18th), will contain more detailed information on how the Government and National Grid determined the draft Strike Prices. The Delivery Plan will also confirm whether or not dedicated biomass plant (without combined heat and power) will be eligible for a CfD. At the same time, Government will publish a Technical Expert Panel Report on National Grid's analysis. Proposed Strike Prices for Nuclear and CCS projects are expected to remain a matter for bilateral negotiation.

The Levy Control Framework

The cost of the CfDs is subject to the Control Framework for DECC levy-funded spending. Annual Upper Limits (based on 2011/2012 prices) have been set out by DECC as follows:

Government has yet to provide detail on how these annual figures will breakdown between the different low-carbon support measures (including CfDs, the RO, the Warm Homes Discount scheme, and small-scale FiTs). Equally, there is no detail on the treatment of unspent monies in any given year.

DECC sets out anticipated deployment for each technology

DECC has published a “Potential 2020 Deployment Sensitivity” for each technology in GW. While stating that the figures do not amount to “Government forecasts”, the inclusion of the figures appears to effectively set out volume targets for each technology (although this is not stated Government policy). Interestingly, the upper-end projection for offshore wind in 2020 has been premised on the achievement of significant cost reductions, and delays to Carbon Capture and Storage (CCS) and nuclear build-out.

Proposed next steps and timetable for the Strike Prices

July 2013: Draft EMR Delivery Plan to be published for consultation (ten weeks), which will include information on the methodology and analysis behind the draft Strike Prices.

Summer 2013: Government to hold workshops for stakeholders during the consultation period. Details will be published on the DECC website.

December 2013: Final Strike Prices to be published (subject to State Aid approval and Royal Assent to the Energy Bill).

Whilst the EMR Update document is primarily focused on the envisaged timetable and next steps towards finalising the CfD structure, it also provides a high-level "policy" summary of developments on the terms of the generic CfD.

Fully termed CfD expected in December

Government has been working with stakeholders and developers to ensure a robust legal CfD framework is put in place. One limb of this has been the continued progress through Parliament of the Energy Bill, which moved to the Committee stage in the House of Lords on 2 July 2013. Royal Assent is still expected to be achieved by the end of 2013. Government has yet to publish its response to the call for evidence on the Supplier Obligation (which will inform much of the draft secondary legislation due to be published in the autumn), but expects to be in a position to do so in July.

The other limb of this process has been Government's refinement of the provisions of the CfD Heads of Terms which were set out in the Operational Framework published alongside the Energy Bill in November last year. Government had originally expected to publish a fully-termed generic CfD in July, but this has now been pushed back to December, although certain key clauses of the CfD are expected to be published in August for discussion with stakeholders.

The headline points are:

15 year contracts for renewables technologies, with flexibility built in for other technologies;

full indexation of the Strike Price (at CPI) for the full term of the CfD;

as expected, intermittent technology will use an hourly day-ahead reference price; there has been a move to a season-ahead reference price for baseload technologies (although Government has acknowledged that year ahead remains a possibility);

generic CfDs will not contain a refinancing gain clause (although such a provision may be included in bilaterally negotiated CfDs);

Change in Law protection is to be provided but is to be fairly limited both in scope and the actual level of protection afforded to generators. Specific reference has been made to:

"material and unforeseen" changes in law;

"general changes in law that have discriminatory effects without objective justification";

"political decisions to shutdown a generator"; and

"certain changes in network charges, relating to the costs of the balancing system and transmission losses";

compensation for Change in Law will be in respect of changes in law which "limit a generator's ability to either deliver its output or to receive appropriate payment". Compensation is stated to "adjust Strike Prices" to reflect (1) 100% Opex costs, (2) a proportion of Capex costs (presumably linked to a concept of amortisation over the lifetime of the asset in question – which may be longer than the CfD term), and (3) lost revenues (over the term of the CfD – not the project). It is unclear whether a deemed output mechanism will be included;

additional flexibility around varying the original capacity proposal upwards and downwards without penalty – both before and after construction. Any further reduction in capacity will lead to reduction in the Strike Price;

the commissioning window remains as previously envisaged by Government, with a reduction in term for a failure to commission in that timeframe, and a loss of the CfD for failure to commission by the agreed longstop date;

force majeure relief (by reference to a reasonable and prudent operator test) will be available, as will flexibility where delays are caused by the network operator;

final, binding arbitration (without a right for Government to impose settlement) will be included as the formal dispute resolution mechanism;

the language around termination of CfDs has been softened and now appears to be primarily focussed on material breaches by the generator, with a suspension period and remediation plan provisions built in; and

metering will use existing settlement arrangements where possible and will be based on loss adjusted net metered energy.

Proposed next steps and timetable for the development of CfD terms

July 2013: Draft EMR Delivery Plan to be published for consultation, along with consultation on RO transitional arrangements.

August 2013: Further detail on CfD terms, including draft contract terms for all "key terms which go to the value of the CfD".

August 2013: More detail on CfD allocation, and Government's response to the call for evidence on the Supplier Obligation.

Summer 2013: Engagement with interested stakeholders, including two separate workshops on CfD terms – dates in August to be confirmed.

October 2013 onwards: Consultation on EMR secondary legislation.

December 2013: Final fully-termed generic CfD to be published.

2014: Full implementation of EMR regime through secondary legislation, with first CfDs to be signed from Q3 2014 onwards.

FID-enabling Renewables Investment Contracts

Government has again reiterated its commitment to working with developers in order to avoid a hiatus in investment. This is particularly relevant given the recent public spotlight on security of supply following Ofgem's and National Grid's announcements on likely system margins. Government has published further details around the eligibility and allocation process for any renewables developers interested in applying for a FID (Final Investment Decision) enabling Investment Contract (or pre-EMR CfD). Information on the principles underlying Investment Contracts can be found in our previous e-bulletin here. "Update 2: Final Investment Decision Enabling for Renewables Investment Contract Allocation" has now been published and builds upon "Update 1: Invitation to Participate" published on 14 March 2013. Update 2 contains significant detail on the procedure to contract and will require careful scrutiny by interested developers.

There has not been any delay to the initial deadline for submissions of applications to participate in Phase 1 (application for, and issue of, letters of qualification and Status Letters), which closed on Monday 1 July 2013. Without receiving a letter notifying them of successful qualification under Phase 1, developers will not be able to participate in Phase 2 of the process. Government has committed to providing all such letters to successful developers by 19 July 2013.

Phase 1 – Eligibility Criteria: the project must constitute a type of renewable electricity generation which is currently eligible to receive support under the RO (ie CCS and nuclear are not covered, as they are being dealt with separately under a bilateral negotiation mechanism), and the developer must also be able to demonstrate that:

credible plans are in place to start generating between 2014 and 2019;

there is significant risk the project would not occur or would be significantly delayed without an Investment Contract;

the project is located in the UK and is not already accredited under the RO; and

the project has an expected nameplate capacity of 50MW+ (onshore) or 100MW+ (offshore).

Phase 2 – Process & Criteria: assuming the developer has successfully applied for participation under Phase 1 and wishes to continue its application for an Investment Contract, the developer must submit to Government evidence to support the evaluation criteria by midday on 6 September 2013. Examples are given of the form of evidence which a developer would be expected to provide to show that the key points for each criteria have been demonstrated.

Government has said that successful applicants will be notified in November 2013, but will not receive a draft Investment Contract or final Strike Price until early 2014 (after the generic CfD and final Strike Prices have been published in December 2013).

Government has said that it does not intend to negotiate either the Strike Price or the terms of the Investment Contract with developers during the Phase 2 process. However, it does acknowledge some possible scope for amendments which do not "materially alter the commercial substance of the agreement or the allocation of commercial risk" – these could be to individual Investment Contracts, or to the form of the draft Investment Contract (and therefore applicable to all developers).

Government will if required, also carry out an affordability assessment and down-selection process including the impact of the overall Levy Control Framework caps discussed above, and potentially specific affordability constraints applicable to Investment Contracts.

Government envisages this process being complete by March 2014, and Investment Contracts being entered into from that point.

Energy Industrial Strategies focus on building the UK supply chain

Government has produced two outward-facing Energy Industrial Strategies, for nuclear and oil and gas. A third, for offshore wind, will follow in mid-July. Government is looking for developers to engage proactively with the supply chain and, where possible, design their projects in a manner that supports the development of competition and sustainability, to ensure that the UK sees a wider economic benefit, and to reduce costs in the medium to long term.

2. Detailed Design Proposals for the Capacity Market published

As part of its Electricity Market Reform project (EMR), Government has proposed the introduction of a series of capacity auctions (known as the Capacity Market). Under the Capacity Market electricity generators and demand response providers will be able to offer capacity at times of system stress in return for steady capacity payments in the year in which they agree to make capacity available. Those who fail to deliver capacity when requested will face financial penalties. Auctions will be used to allocate capacity agreements to market participants.

The Department of Energy and Climate Change (DECC) expects that the Capacity Market will encourage project developers to make investment decisions about de-mothballing or upgrading existing plants and commissioning new plants. As a result of this DECC envisages an increase in the amount of demand response capacity available.

The cost of the Capacity Market, including the capacity payments to be paid to capacity providers, will be apportioned to suppliers according to their market share. Therefore, consumers will ultimately pick up the bill. DECC maintains, however, that consumers will benefit from reduced wholesale prices and protection against price volatility and blackouts.

DECC has also raised the possibility of zonal auctions, provided that Ofgem considers that they are appropriate to help manage system constraints.

Under DECC's proposals, and subject to State Aid approval, the first Capacity Market auction will be held in 2014 for supplies from winter 2018 (ie, a four years-ahead auction). The first year-ahead auction, which will supplement the 2014 auction, is due to take place in late 2017.

Before this a consultation will be held on the enduring reliability standard to be used in determining the amount of capacity to be auctioned. DECC expects to publish this consultation later in July 2013 along with the first EMR Delivery Plan, with a view to establishing the reliability standard in December 2013. A consultation will also be launched in October 2013 on the detailed rules for the Capacity Market.

Proposed next steps and timetable for the Capacity Market

July 2013: Consultation on enduring reliability standard.

October 2013: Consultation on detailed rules.

July 2014: Legislation to come into force.

2014: 1st Four year auction for supplies from winter 2018.

Late 2017: 1st year ahead auction held.

Capacity Market to be technology neutral

The Capacity Market is designed to be technology neutral, although separate auctions for demand side response capacity (including embedded generation and smaller storage) will be held to enable time-banded products to be offered. In addition, lower penalties will initially apply to demand side response capacity, with penalties being capped at the provider's total annual capacity payment.

Those already accredited under renewables incentive schemes (eg, the Renewables Obligation, small-scale feed-in tariffs or feed-in tariffs based on Contracts for Difference) will be ineligible to participate in the Capacity Market, as will interconnected capacity for the time being. However, DECC raises the possibility that renewable combined heat and power plants receiving support through the Renewable Heat Incentive may be eligible to participate. Those providing balancing services to National Grid will also be eligible to take part in the Capacity Market.

Auction to be "pay as clear"

Seven months ahead of each auction, a pre-qualification round will be held. As previously confirmed, all eligible generation will be required to participate in the pre-qualification stage of the auction, even if it does not intend to bid.

The auction itself will operate using a "pay as clear" system with a "descending clock" format. All participants will receive the clearing price set by the marginal bidder (ie, the most expensive successful bidder). In order to mitigate the risk of collusion, bidders will be divided into "price makers" (which can set the price) and "price takers" (which can only bid up to a relatively low threshold). Multiple rounds will be held until the auction "discovers" the minimum price at which there is sufficient capacity.

National Grid will have the key role in the Capacity Market

National Grid will have a central role to play in the operation of the Capacity Market. It will provide Government with analysis on the level of capacity required to meet the enduring capacity standard, in conjunction with a panel of technical experts. The system operator will also centrally administer the de-rating of generating capacity during the pre-qualification stage of the auction in order to mitigate the risk of generators over- or understating available capacity. National Grid will be responsible for administering the auctions and issuing capacity payments to successful bidders with Elexon acting as settlement agent.

Secondary market

DECC has confirmed that secondary trading of capacity agreements will be possible in the year ahead of the delivery year. Those with capacity agreements will be able to hedge their position by contracting with eligible capacity which did not obtain a contract in the auction, new capacity and capacity which opted out of the auction but which has been verified by National Grid as providing eligible capacity. Financial hedging of liability will be permitted at any stage.

3. DECC's Response to its Call for Evidence on Renewable Energy Trading

20% of energy from renewable sources by 2020

In 2009, the leaders of EU countries agreed that 20% of Europe's energy should come from renewable sources by 2020 – the EU Renewable Energy Directive subsequently set specific targets to be achieved by each EU country. The Directive also made provision for the countries to cooperate amongst themselves for the achievement of these targets – this lends a certain degree of "flexibility" to EU states as to how these targets may be achieved. Recently the UK Government has noted that such "flexibility mechanisms" would:

maximise the range of available options to support the achievement of the 2020 renewable energy target; though Government is confident that the target could be met through domestic action alone, it remains receptive to other options which could reduce the risk of not meeting the target; and

be a new source of growth, jobs and clean electricity; given Europe's diverse and uneven range of renewable sources, there may be a mismatch between supply and the rising demand for renewable electricity which could be addressed by trade. Given the UK's geographical location, Government has also noted the potential to export renewable energy to other regions.

For these reasons, the UK Government has been considering trading renewable energy across its borders. In order to take the policy forward, the Department of Energy and Climate Change (DECC) issued a call for evidence on renewable energy trading in April 2012, which sought views on the availability and potential of such arrangements.

While the primary focus appears to be the introduction of a mechanism to allow trading of renewable electricity between the UK and Ireland, the response talks mainly in terms of "energy" in the wider sense and leaves open the possibility trading with other member states or outside of the European Union.

Respondents favour physical trading over statistical transfer

The majority of respondents opposed a purely "statistical transfer" (payment made for new renewable generation that is not consumed in the country that pays, i.e. there is no physical, but only a "statistical" transfer, comprising of a transfer of renewable credits) owing to the mechanism's uncertainty, inability to confer lasting benefit, and impact on investor confidence. Questions were also raised about the impact of any large statistical transfers on the operation of the relevant third party's electricity market.

In contrast, there was a strong interest across a range of experienced developers in different regions for joint trading projects (i.e. projects where the country with the most favourable conditions, in terms of resource and/or cost of deployment, will host the project, with other countries benefiting from production). However, some respondents argued against excessive reliance on trading, citing security of supply and the long-term decarbonisation pathways as reasons for caution.

Non-UK project developers noted that the treatment of such projects would need to be on a non-discriminatory basis. There were also some concerns voiced about the impact on investment of moving towards cross-border trading too quickly. Some felt that Government should seek to mitigate this – for example by capping the total amount of generation to be imported from abroad – others felt that there should be a decision on trading only later in the decade.

Most respondents were clear that there were a range of issues which needed to be overcome in order to allow trading to work, and the need for early clarity from Government and the regulator in order to reduce regulatory uncertainty. These issues include:

political uncertainty;

the expected level of subsidy for generators and how subsidies would be allocated;

planning issues and regulatory issues around the transmission asset; and

the extension of the CfD regime to non-UK projects and the impact of trading on the current Renewables Obligation regime.

The potential for statistical transfers remains unclear

From the responses received, Government has noted that the potential costs and contribution of statistical transfers remains unknown at this stage. This is supported by statements of the EU Commission which suggest that the availability of any surplus renewables across Europe – and the costs or feasibility of statistical transfer – will remain unclear for some time. Therefore, Government does not believe that it is possible to make plans for engaging in statistical transfers at this stage, but will keep the position under review.

DECC's work will focus on physical trading

DECC has noted that its work this year will focus on physical trading, concentrating on the following areas:

the drafting of an Intergovernmental Agreement with the Republic of Ireland (Government is also discussing with the EU Commission how such an agreement would work in practice);

other technical issues required in order to achieve the Intergovernmental Agreement by the turn of 2013/2014;

development of the UK Government's approach to support mechanisms; this includes the mechanism's structure, how support level might be set, and how it could be allocated;

the amount of the non-UK renewable energy that might be desirable or required, and whether or how this should be constrained or capped;

the treatment of the transmission asset; and

ensuring that any decisions taken for meeting the medium-term objective of the 2020 target do not preclude the longer term growth in market integration and trading that Government sees as strategically important.

Plans underway for an Intergovernmental agreement with Government of Ireland

The UK Government has begun a programme of work with the Irish Government to address some of the issues raised by the respondents to the call for evidence given that: (a) there are a number of further-developed projects in the Republic of Ireland; and (b) the potential for wider economic benefits given its geographic proximity to the United Kingdom:

the UK Government is currently exploring a number of scenarios – for example, it has been noted that the UK could collaborate with the Republic of Ireland on a "first phase" of international trading for the purpose of meeting the 2020 target (which would also serve as a vehicle for resolving a series of barriers to wider market and system integration with Europe);

DECC has plans to take a decision later in the year and has begun discussions through the British / Irish Council; and

DECC has also opened discussion with the EU Commission (who remain strongly supportive of Member States' use of flexibility mechanisms).

No definitive position on cross-border energy trading

DECC has noted that the Response Paper is not to be regarded as a final or definitive statement of UK's position on international energy trading – Government intention is to set out a clearer preferred policy position at the end of 2013 and it would keep in touch with the interested parties as the situation progresses through the year.

On 27th July 2013 National Grid issued a consultation setting out proposals for two new measures, Demand Side Balancing Reserve and Supplemental Balancing Reserve, to help balance the transmission system in the face of projected mid-decade capacity shortages. The deadline for responses is the 26th July 2013. There will be an industry workshop held at a yet unconfirmed date in July 2013.

The objective of Demand Side Balancing Reserve (DSBR) is to create a system where there is broader demand side participation in providing balancing services through the use of a half hourly settlement metering, in advance of the demand side participation expected under the new EMR Capacity Market. National Grid hopes that it will stimulate participation customers with half hourly meters (acting on their own behalf or though their supplier as their agent) as well as electricity suppliers. Consequently, a simple form of standard contract is envisaged, with no onerous penalties for non-performance.

In contrast, Supplemental Balancing Reserve (SBR) is aimed at medium sized generators (50MW or more) and larger demand reducers. The objective of SBR is to provide additional secondary capacity in periods of system stress without the need to activate existing emergency measures available to National Grid. A more complex form of contract and pricing will apply with penalties for non-performance.

The proposals are for both DSBR and SBR to sit alongside the tools currently available to National Grid (such as Short Term Operating Reserve (STOR)) and the proposed new Capacity Agreements to be entered into under the Capacity Market.

Two proposed products for Demand Side Balancing Reserve

There are two proposed DSBR products which will be offered periodically in tender rounds. Both aim to incentivise the reduction of demand by users at peak times and, where possible, increase contributions into the grid from embedded generation that is situated "behind the meter". National Grid is consulting on how DSBR contracted plant will interface with existing triad demand reduction measures.

Product One

National Grid will procure a quantity of demand reduction capability at peak times on non-holiday weekdays between 4-8pm in the months of November to February inclusive. Two hours notice will usually be given for the required demand reduction, by a web or smart phone based application. This will be incentivised by:

a set up payment of between £5/kW per year and £10/kW per year (to be decided after the consultation); and

a usage payment ranging from £500/MWh to £15,000/ MWh, determined in accordance to the Value of Lost Load (VoLL).

The service will only be called in economic precedence with other balancing services, and so National Grid expects it to be called fairly infrequently.

Product Two

This is identical to Product One save that bidders not receive a set up payment and will therefore only receive payment if they are called.

Participation in DSBR will be restricted

Participation in the scheme will be restricted to sites:

that are already half hourly metered; and

whose half hourly data is already used for settlement (or if not already used for settlement the provider can show that the data would be of settlement quality); and

which have a utilisation price of over £500/MWh or greater; and

which are not BM Units subject to the requirement under the Grid Code to submit Physical Notifications.

This will exclude larger plant which already contributes to grid security through the balancing mechanism and participation in the wholesale energy markets.

Supplemental Balancing Reserve to provide a last resort measure

SBR will be a last resort measure for balancing the Grid should other balancing arrangements prove insufficient and is aimed at capacity that would not otherwise be available to the energy market. SBR may consist of:

capacity from otherwise mothballed power plant, no longer participating in the wholesale energy market; or

demand reduction.

Procurement of capacity for the SBR is expected to be done at least 12 months in advance. National Grid will pay providers:

a capacity fee (also referred to in the documents as a capability fee);

a utilisation fee; and

(if necessary) warming costs.

Demand reduction for SBR will differ from that of the DSBR in that all SBR participants are to be available whenever required by the National Grid within the contracted availability periods which are expected to be 6am to 8pm on non-holiday weekdays, and non-delivery charges will apply. While National Grid is still working out the interfaces between plant contracted under SBR and the balancing mechanism and imbalance settlement pricing, and it is anticipated that output from a plant contracted under SBR would not be credited to the participant's energy account.

In order to be a provider of SBR the plant has to be deemed "additional" meaning:

that it would not have been available for despatch had the SBR contract not been awarded; and

it does not otherwise participate in the market for energy or balancing purposes.

Tender rounds to commence 2013/2014

National Grid proposes for both DSBR and SBR, to hold tender rounds in 2013/14 for services to be provided in 2014/15 and 2015/16. Interested participants are also invited to offer trial DSBR services before that time.